ActRaiser's manual refers to this item generically as "Projectiles". Once obtained, the Master will shoot a blue crescent beam with each sword slash, a beam that will pierce through any targets in its path. It also doubles the Master's damage. The Flame Sword will last until the end of an Act.
The Flame Sword is very rare, and only appears in two places: Aitos, where it's of great assistance in damaging the Serpent, and Death Heim, where it's automatically granted for the final battle against Tanzra.