The equipments I'm using
The answer to your question is dependent upon the brand of preamp or processor you are using. Many home theater processors and receivers convert everything to digital at the inputs. Others, however, retain analog signals if you are playing back in stereo. I am not sure about the Parasound but I would guess it converts everything to digital upon input regardless of playback mode. Most processors do these days.
If the processor converts to digital and then back to analog, you may find that CD's sound better using the digital output of your CD player rather than the analog outputs. However the question is not so simple... you have to consider whether the DAC in your CD player is better than in the processor. More often than not it is better as most home theater processors are fairly mediocre for music purposes. However there are exceptions. It is almost a forgone conclusion that the Meridian's onboard DAC is going to sound far superior to the Parasound processor's.
Another factor is the interaction of the transport and DAC, and the quality of the digital cable involved. In some cases the DAC in a processor will not be a good match for the transport. This is especially true if the processor is a new upsampling job with 24/192 or 24/96 and the transport is an older model which does not have a clock output that syncs with anything but 44/16 then you may run into some clock syncing problems.
So... as with all things audio related... try both and listen to see which sounds better to you.
I've noticed one thing is that sometimes when playing cd's the overload light is on for few seconds on the processor and that because the internal adc is overloaded, so I'm answering my own question "yes the processor is using adc and dac before sending it to the amp".
But is it still process signals if it is hooked up to the 5.1 input ? When I connect to 5.1 input, I need less volume to listen to music as compared to regular analog input and seems to me soundstage is little bit better.
I need to play with both and decide. I just want to find out if anyone have noticed this or know the difference between the processing of signals.
5.1 inputs are almost always analog passthroughs by default and don't digitally process the signal, but I don't know specifically about the Parasound. From what you describe it seems as if there is no digitization taking place through the 5.1 input, but if I were you I'd call Parasound to know for sure. While you're at it you should also ask them if all the analog inputs digitize the incoming analog signal -- sometimes there is one analog input that avoids the digital circuitry. Best of luck.