What output encoding is your XSL set to use? What encoding is the input document? Where's the input coming from, and where was it saved/uploaded/dowloaded in the meantime?
XML and XSL should default to using UTF-8 if nothing else is specified. But clearly, something's going wrong here.
One thing which might happen is, the XML is being served up by a web server which is set by default to serve in ISO-8859-1, a pretty good default ... pre-Unicode.
Slightly off-topic, but Joel's very instructive article about text encodings was an eye-opener to me. There are a lot of people out there who are otherwise very smart about programming, but who persist in thinking there's such a thing as "plain text" or calling their text "ASCII" or "ANSI". It's an issue you really need to get to grips with if you haven't yet.