There are many different explanations of how hypnosis works. This is my working theory:
To understand how hypnosis works, it his helpful to think of the mind as having several parts;
all working simultaneously.
During normal waking hours, the input processor collects sights, sounds smells, etc. and forwards them to the critical thought processor. The memory processor retrieves memories which may be related to the inputs. The critical thought processor compares the new inputs to existing memories and determines if the new inputs are relevant and valid. Normally the anatomical controller runs independantly in the background, but if the evaluation of the inputs suggest its time for sex, then the anatomical controller sends the necessary signals to the body for sexual arousal, i.e. more blood to the skin and genitals.
Normally, a person's state of mind permits them to see and hear everything around them. While part of their mind focuses on what they are doing, part of their mind is searching their memories for information that will help them interpret what they see, hear or feel; and part of their mind is alert for something else that may require their attention (like the ringing of the phone). But when hypnotized and sexually aroused, the mind focuses more completely on the sexual stimuli. The mind no longer analyzes inputs, it just accepts them and allows them to go directly anatomical controller, which allows a person to feel more intense arousal in their body.