An illuminated letter is a letter in manuscript that is decorated and is the first letter of the sentence for those who are reading it to identify the beginning of the script. Usually these letters were decorated in gold are silver to give the impression of illumination (the letters do not literally light up, its more of a metaphor). Besides being embellished in gold or silver the letters were decorated with elaborate designs, imagery and color.
Examples of Illuminated Letters
A drop cap is the first letter of a paragraph that is enlarged to "drop" down two or more lines, as in the next paragraph.
Examples of Drop Caps