"A witness said residents of the island of Yeonpyeong, off the west coast of the peninsula near a disputed maritime border, had been evacuated.
Yonhap news agency said four South Korean soldiers had been wounded in the shelling, the biggest attack in years.
YTN television quoted a witness as saying 60 to 70 houses were on fire after the shelling and TV footage showed plumes of smoke coming from the island. It said a South Korean fighter jet had been deployed to the west coast after the shelling.
"Houses and mountains are on fire and people are evacuating. You can't see very well because of plumes of smoke," a witness on the island told YTN.
"People are frightened to death and shelling continues as we speak," the witness said.
News of the exchange of fire sent the won tumbling in offshore markets with the 1-month won down in NDF trading.
The impact was felt internationally, with U.S. 10-year Treasury futures rising and the Japanese yen falling.
South Korea's military confirmed the exchange of firing, without providing more details.
The attack comes just as a U.S. envoy is traveling to the region after revelations that the North is moving ahead with uranium enrichment, a possible second path to manufacture material for atomic weapons."