At this moment, the Microsoft Office Word app for Windows Phone 8.1 is not a fully functional document editor - at least if you'll compare it with the PC version.
The most that can be done seems to be changing the format of the text (highlight color, bold, italics, underline, font size, font color), but it seems that not even the font type can be changed. Basic bullets, comments and searching for words can also be done, but nothing on margins, tables, etc. Notice also that the page view is styled such that it looks like you're reading a continuous webpage, rather than a paginated document.
News has been circulating the Microsoft is preparing to release universal Microsoft Office apps, which should have more features than what we have right now.
But to answer your questions as to how to create a word document, simply:
1. open Microsoft Office,
2. tap on the + symbol (or "New"),
3. select "Word" blank document,
4. type something into that document,
5. tap on the three dots at the lower right of the screen,
6. tap on "save as...",
7. type the file name and choose the location where you want to save the file.
More details can be found in the link that was shared to us by Laura in post #2.