Israeli officials say soldiers spotted four men Friday on their way to the security fence along the border of the Gaza Strip.
The troops opened fire, hitting the group as they were attempting to place bombs in the area. All of the Palestinians had come from a nearby refugee camp.
Israeli army officials say they contacted Palestinian officials to have the dead or wounded removed.
Earlier, Palestinian militants fired four homemade Kassam rockets from the Gaza Strip into Israel. Two of the rockets landed in residential areas in Sderot, in the southern Negev area of Israel. At least five Israelis were treated for shock.
The escalation of rocket attacks from Gaza in recent weeks threatens to complicate Israeli Prime Minister Ariel Sharon's plan to withdraw troops and Jewish settlers from the Gaza Strip by the end of next year.
So far this month, Palestinians have fired about 60 homemade rockets at Jewish settlements in Gaza and across the border.
The firing came despite intense efforts by Israel to halt the attacks. Last month, Israeli forces moved into the Palestinian town of Beit Hanoun, in the northern Gaza Strip, after two Israelis were killed by a rocket in Sderot.
Troops have bulldozed farmland in an effort to expose launching areas for the rockets.
On Friday, Israeli forces moved to the outskirts of Beit Lahiya, another Palestinian town in northern Gaza suspected of being used to fire rockets at Israeli targets.