[Kombisaurus]

As stated before, all JPG's start out life as RAW.
A common metaphore being that a RAW file represents a bunch of ingredients while a JPG file represents a finished cake. While it is possible to change a cake that is already baked (add icing, cream, etc) there are many things that are better to change before the ingredients are mixed or baked.

As also stated, RAW images are in fact monochrome images in almost all digital cameras (although they are not black/white). This is because the sensors on most digital cameras can only respond to the luminance of light, not its colour. A multi-colour filter called a "Bayer Filter" is used in front of the sensor to encode colour information into these luminance values, and then software tries to demosaic/interpolate/guesstimate the colour information based on what it knows about the filter colour in front of each pixel and the pixels surrounding it. There is a good article on Wikipedia that describes how Bayer Filters work.
Note that although a RAW file is effectively a monochrome image, a JPG image does not contain "more" colour information - simply the "decoded" colour information from the RAW.
Another lesser-discussed reason for shooting RAW is because the RAW conversion software on PC's is significantly more sophisticated than the software inside the camera, and can potentially do a much better job than the camera of this demosaicing/colouring process, not to mention the many other complex tasks in RAW conversion such as sharpening and noise-reduction. Added to that is the fact that RAW files are usually 12-bit instead of the 8-bit of JPG (each pixel can represent 4096 luminance values instead of 256 - albeit using a different scale), and that RAW files are lossless instead of lossy as already stated, and you begin to see many small benefits adding up to a subtle but significant difference.

Schell, Polly is correct about Photoshop CS2 requiring a newer version of Adobe Camera Raw (ACR) to read 350D files. It seems the 350D just missed out on the deadline for getting support included in the initial release of CS2.
Incidently, the Canon software Digital Photo Professional (DPP) converts RAW files just fine... I normally hate applications that come bundled with hardware, but DPP is a definate exception to this rule in my mind. It might not be on top of the list for workflow, but the quality of its output is very highly regarded. I have tried about half a dozen others, and while I can see how they might appeal to other people, I keep coming back to DPP for the most consistent and pleasing results.
And Canon have just released a new version of DPP (available as a free download) which is even better than v1.6 which came bundled with the 350D. It is well worth the download.
But it seems that a favourite RAW converter is quite a personal choice. Be aware that the differences are greater than just the workflow or list of specs might suggest. Different converters really do give different "flavours" to your shots, and suit different ways of working. I'm about to have a bit of a play with SilkyPix - a new japanese RAW converter I've just read about on Rob Galbraith.