A flat screen display will have to convert a 1080 interlaced picture to it's native resolution (720 or 1080 progressive for regular HD).
The TV won't have a setting for this but your source might. 1080i is better for still pictures and 720p is better for motion. That's why some channels chose to broadcast in 720p which requires more bandwidth that 1080i, 1080i is the equivalent or 540p so if your TV shows that the source is 720p that's fine.
When you connect your source with HDMI the source sets the output to the highest the display will handle.