Unlocking this achievement will also unlock Fairies as a playable race.
Head to Mythrandir (elf city) and cycle through screens until you get the quest to find the missing arrow. Now, head back to the Forest (second section of forest, not the first). Eventually you'll notice a miniature city and you'll learn that it's a Fairy city and they have the arrow. They'll need you to defeat the monster that is eating them in order for them to give you the arrow.
It's also worth noting that if you're a Tiefling you can instead use diplomacy as an option to get the demon to go away.