Yes, accordingly to there proportions. Why don't you just try it?...:-)
And yes, the thumbs are produced on the fly. They are within the cache folder and look like this:
image.jpg_100_cw85_ch85.jpg (meaning thumbnail size 100 with 85 crop height and width). I have never tried to copy thumbs manually, you probably could do that, but you have to name them that way and have to match the settings, otherwise they would get processed. And keep in mind that if you delete the cache for the gallery or an album, they all would be gone.