Nose cones, along with fins, are one of the most critical aerodynamic components of a rocket. A simple paper cone taped on top of the rocket is enough to significantly reduce the rocket's coefficient of friction, however more complex shapes may be used to further improve a rocket's performance (and some are surprisingly easy to make). There are three common shapes used for nose cones: conical, ogive and parabolic, as shown in the diagram below.
A common misconception is that the most aerodynamis is the conical shaped nose cone. This probably comes from the fact that frequently space-going vehicles have nose cones this shape (for example the space shuttle's solid rocket boosters). However this shape is only suitable for supersonic flights (above the speed of sound). For water rockets, which only achieve a speed of about 1/4 to 1/3 the speed of sound, a parabolic shape turns out to be the most efficient. Similarly, you often see model rockets (the pyrotechnic type) with parabolic nose cones as well. Several methods exist to construct nose cones of this shape. The simplest and quickest is to use the top of another bottle cut off and taped or glued (or attached some other way) to the top of the rocket. Another technique that is used is guppying. This involves heating the bottom of a pressurised bottle so that it expands into a rounded shape. While this method does give very good results, it takes a lot of practice to get right.
A guppied bottle (picture courtesy Clifford Heath; http://polyplex.org/cjh/rockets/)
However, to be perfectly honest, while aerodynamics are quite important in water rocketry, the difference between a conical nose cone and a parabolic nose cone is not that significant. With this in mind, you often come across people who make conical paper nose cones, for example Robert Youens' Coney design (note however that the very long cone is also an integral part of the overall design in order to make the rocket backslide).
Another common type of nose cone is one made out of foam. Using a nicely shaped end of a 'foam noodle' (those cylindrical shaped foam 'toys' used for floating in pools) can be very effective - they are lightweight, aerodynamic and allow you to use 'bounce' recovery (where the nose cone compresses and absorbs the rocket's energy upon impact). Have a look at Lonnie's page for more information on making one of these nose cones. For some theory about bounce recovery and crush zones, take a look at my crush zone theory page.