No casualties were reported, although some residents of Hapsuri township in the South Korean border area of Yeoncheon were evacuated to shelters as a precaution, a defence ministry spokesman said.
While naval confrontations along the two rivals' disputed maritime border occur from time to time, any military engagement across the heavily-militarised land frontier is extremely rare.
The exchange of fire followed the launch from Hapsuri at 2:00pm (0500 GMT) of a number of gas-filled balloons with attached bundles of leaflets denouncing the North Korean regime.
Two hours after the launch, rounds of heavy machine gun fire were heard from the North Korean side, lasting about 20 minutes, the ministry spokesman said.
After a number of high-calibre rounds were found to have fallen near South Korean border posts, the South retaliated by firing some 40 rounds "towards the North's guard posts," he added.
"We are closely monitoring movements of the North Korean military," he said.
The balloon launch from Hapsuri followed a similar morning exercise by another group of activists in Paju, further along the border to the west, who released around 200,000 leaflets.
Seoul allowed both exercises to go ahead, despite prior warnings from Pyongyang of "catastrophic" consequences.
The launches coincided with the 69th anniversary of North Korea's ruling party -- a major commemorative event for the Pyongyang regime.
Some of the balloons carried messages denouncing North Korean leader Kim Jong-Un, whose absence from public view for more than a month has fuelled rumours of serious health problems.
South Korean activists -- many of them defectors from the isolated North -- have been carrying out similar leaflet launches for years.
At times of heightened cross-border tension, the South Korean authorities have stopped the launches going ahead for fear of retaliation.
Last month, North Korea sent a rare message to the South Korean president's office, demanding an end to the leafleting.
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