When you add a file to iTunes - whether an audio or video file - iTunes just records a reference in its database that points at the location of the file. If you right click on a file you can choose the option to Show in Finder and it will show you the source file that it is using. iTunes doesn't care where the files are kept - some can be kept on the internal drive, some on an external or NAS - it doesn't matter.
So the short answer is no, iTunes does not duplicate the file when you add it to your library, and yes, you must keep that source file you see in the Finder.
Addendum: Your post is a bit ambiguous. If what you mean is you have a source file, say a wmv or DVD rip, and you encode it to a format for iTunes use, then YES, you now have two files - the original source file and the iTunes version. You may discard the original version if you like (but note that quality is generally lost during the conversion, so the source is likely of higher quality).