Microsoft finally announces details about the backward compatibility of the Xbox 360. More than 200 Xbox games will work on the new Xbox 360.

This is great news for everybody who already owns an original Xbox. Amongst the compatible games are blockbuster games like HALO, HALO 2, Grand Theft Auto series and Half-Life 2.
See the full list here.
The backward compatibility on Xbox 360 is done through software. The emulation software is available for free through Xbox Live or xbox.com. Playing original Xbox games on the Xbox 360 benefit from the Xbox HD capabilities. Every original Xbox game will be up-scaled to 720p and 1080i, and will take advantage of Xbox 360’s anti-aliasing capabilities.
One important information is that you need the 20GB hard-drive for backward compatibility to work.
So the core Xbox 360 package alone will not do it. You need the xbox 360 hard-drive. The emulator software recreates the procedures and functions of Xbox using stored data on the hard drive.
More details in this Q&A about Xbox 360 backward compatibility with Microsoft's Todd Holmdahl on xbox.com.