Diegetic and non-diegetic sound
Also said as In-world sound, Source music, Underscore
Diegetic sound exists inside the game's world, so its characters could hear it: a radio, a footstep. Non-diegetic sound lays over the world for you alone: the score, a menu click.
Moving a sound between the two is a powerful trick. Music that turns out to come from a real radio makes a moment feel suddenly real, and the player can walk away from it.
Say it
“Play this song from the radio on the desk, not over the scene: band-pass it to 350 Hz to 2.8 kHz, attenuate it with distance, and let the player switch it off.”
Where you’ve seen it
Silent Hill's pocket radio plays static when monsters are near, without saying where: a warning that exists in the character's hands. Grand Theft Auto's music mostly comes from the car radio, so you can change the station or get out and leave it.
Not to be confused with ambience
Ambience is one kind of diegetic sound. Diegetic covers anything in the world, including a song playing on a jukebox.