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there are two spy quests. one is to go to an enemy town and meet with a friendly spy. the freindly spy is any town person whon you use the password on.

the other quest is to follow an enemy spy when he leaves you town to report to his master, upon accepting the quest he instantly leaves the town and you need to have tracking, follow the tracks made by a single person till you find his lord
 
For the follow the spy, even if you lose track of him, you can just wander around until you see him. He seems to be near castles, towns, villages. I've never successfully followed a spy.
 
i've done it once, like i said knowing he leaves instantly and having tracking helps a LOT. in fact i'm tempted to say a high level of tracking is required to do this quest as it was intended
 
I actually completed this one a day or two again--maybe just by luck. Couldn't find the guy, waited outside the castle for a while then gave up on it. A little later I noticed a group of 12, including one "Ordinary Townsperson," standing by the forest on the Swadian/Rhodok border (pretty far away). The group was kind of a neon purple color and was just standing there waiting.

When I bumped into them my greeting was "You are under arrest by orders of King Ragnar!" I attacked, chopped down the guards but made sure to use a mace to knock the townsperson guy out (instead of killing him). So that worked. Then, when I exited the battle I had automatically found the spy too. Took him down in a one-on-one with a mace too, and had them both captured. Ragnar loved me--finally some validation in life! Just kidding...hope this helps.