@cpb: Yes you have to go to “Appearance => Theme Options => Homepage Settings => Homepage Featured Content Options”. Then click on Add images. It will open the media uploader box. If this is not working then there must be some issue in your installation.
To check that, you can go to “Media => Add New” and upload the image from there. If this works fine then let me know it. If this works fine then you can just copy the image url and page it in the “Image” box for Homepage Featured Content Options.