The best case scenario would be to compress the height of the images to the same height as you've set the slideshow to be. This way, no stretching or compromising has to be done, so the browser shows it more smoothly and second it's going to cost you less server work per page load.
Microsoft Office 2010 comes with a couple of tools to resize images easily and without losing the original resolutions. There are also numerous websites that will do the same for you. For instance, Google for "Compress images".
If you know anything about image DPI (Dots Per Inch), it's nice to keep this in mind when compressing your images. DPI greatly affects the size of your image files. For website images it's recommended to have somewhere around 75-150 DPI. More information here.
The format of the images is not very important, as long as WordPress supports it you should be fine. Most commonly the .jpg and .png image formats are used on the web.