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Water in Second Life is a property of sims and the height of the water can be edited through the estate window. Water can be covered by land but can not be contained (although the appearance of it being contained in a hole can be given). Water has no effect on avatars or objects unless an object is scripted in some way to react to the water.
The visual appearance of water can be different depending on the settings. With "Water Ripple" on, the water appears to ripple as well as objects and avatars below it. The reflection of the sun also gives water depth and the ripples change based on wind and terrain in that area (shallow pools are more rippled while the ocean is less so). With "Water Ripple" off, the water has just a simple animated texture on it. While in the water a blue fog is visible regardless of the settings.