there are 3 generations of apple TV.
1st Gen has a hard drive and can store files locally - This is quite old now
2nd Gen is 720p and can be jailbroken (no hard drive needs to stream files over a network)
3rd Gen (latest) is 1080p but cannot be jailbroken. Looks identical to the 2nd Gen
Jailbreaking;
Similar to jailbreaking phones, jailbreaking the apple TV means you can add functanility, which include some apps and streams from "other" sources

You can also install another media player such as PLEX or XMBC.
With a non jailbroken apple tv 2 or 3 you need to stream your films / tv shows from a computer running itunes. This means that all your content needs to be in an itunes friendly format (mp4/m4v) so if you have any AVI's or MKV's then they need to be converted and imported into iTunes.
IF you jailbreak your apple TV2 then you can install XBMC or PLEX which will allow you to steam your AVI's or MKV's straight to the apple TV without converting them.
However, seeing as the 2nd Gen apple TV's are the only ones that can be jailbroken they fetch a premium 2nd hand. The RRP was originally £99 but they tend to go on
eBay for £150 +. The 3rd Gen's can be brought for around £80 new.
I have 3 x 3rd Gens and there great. All of my content is stored neatly in itunes and i can stream my music / movies / tv shows to any of my idevices including my apple TV's
I originally had a 2nd Gen but didnt jailbreak it and ended up selling it on ebay for £160 and buying 2 3rd Gens instead.
Hope this helps