A safe technology bet these days is nothing more than an oxymoron. When the king-daddy of tech,


(MSFT) - Get Report

, is down 37% since the beginning of the year, it seems nothing is sacred anymore.

So when

DuPont Photomasks


recently issued $100 million worth of zero-coupon, zero-yield convertible notes, in-the-know investors scrambled to buy.

Convertibles allow holders the opportunity to "convert" their investment into a designated number of shares of common stock. Investors willing to forego annual interest payments (that's what zero-coupon means) get the opportunity to buy shares of a speculative (but hopefully promising) company with little downside risk. If the stock price rises, you can convert your notes to shares and enjoy the ride. If the stock price falls, you'll get your investment in the notes back in four years.

The DuPont Photomasks deal "was oversubscribed and highly demanded," says Jim Barry, managing director and portfolio manager at

Froley, Revy Investment

, a Los Angeles investment firm that specializes in convertibles.

A lot of companies, including

Nabors Industries

(NBR) - Get Report


Anadarko Petroleum

(APC) - Get Report


Global Marine


, have been issuing


, zero-coupon convertibles. (I'll explain the difference momentarily.)

We have seen very few zero-coupon, zero-yield offerings. But they might be the next-generation financing alternative for young companies that need to raise cash, says Robert Willens, a managing director and strategic tax guru at

Lehman Brothers

in New York.

If you missed the June 26 DuPont Photomasks offering, tough luck. The secondary market is pretty thin. But you should understand the basics of zero-coupon, zero-yield products so you can be ready to jump on any future offerings.

Like a Stock With No Dividend

DuPont Photomasks issued four-year notes redeemable on July 24, 2004. In addition to paying no interest, these convertibles have zero yield. Typically, a bond is issued at a discount to its face value and is later redeemed at face value. The difference between these figures, expressed as a percentage, is the yield.

So, these bonds offer no yield and no annual income. Why would anyone buy them?

"You're buying these notes strictly to have the option to convert to shares," says Martin Nissenbaum, national director of personal income tax planning at

Ernst & Young

. "It's basically a market play with no downside." (Of course, there is a lost-opportunity cost of having your money sit idle for four years if there's another bull run in the stock market.)

Considering the market's recent instability, it could be a good play. It's somewhat like investing in a nondividend-paying stock. You take your chances that it could stay flat or go up. But when buying a stock, you take on the risk that it will fall in price, possibly to zero. At least here, you have a floor.

The DuPont Photomasks notes were issued at a face value of $100. Holders can convert them into common stock at any time on or before July 24, 2004 for $106.26 per share. The stock was trading around 69 on Thursday, so that's about a 54% conversion premium. Sounds high, sure. But you're betting the stock is going to jump way above $106.26.

DuPont Photomasks is a 36%-owned subsidiary of


(DD) - Get Report

. It provides the photomask industry with manufacturing networks. Photomasks are templates for the production of semiconductors. So it's a high tech company, which translates into a risky investment. "If you just buy the stock, you could lose your investment if the company dies," notes Willens. "But if you buy the convertible, you'll have a chance to get your investment back."

What's also unusual about these convertibles is that they are backed by the parent company. "That's the first that I have seen," says Bruce Hyman, a director in

Standard & Poor's

hi-tech group, which rated the bonds AA-minus, its fourth-highest investment grade. "That's what enables the convertibles to get zero yield. If you did not have a guarantee from DuPont, you'd have

to offer investors a higher yield," says Barry of Froley, Revy Investment.

Convert to the Tax Perks

The best part about these zero-yield notes is that there is no imputed interest to report for tax purposes, notes Willens. "So you've got a bond-like investment with no interest to report."

With regular zeros, you get taxed on what's called the "imputed interest," an amount based on the note's yield. Imputed interest is effectively the interest you would have received if the bonds carried coupons. Check out this

bonds primer for more on zero-coupon bonds.

The conversion to stock is tax-free, except for any cash received in lieu of a fractional share of common stock, says Nissenbaum. In addition, your original cost basis in the convertible notes becomes your basis in the new stock. And your holding period starts the day you purchase the notes and is carried over to the converted stock.

So not only do zero-coupon, zero-yield convertibles have some tax perks, but they also offer investors a hedged way to buy stock in a company and still have some downside protection.

They might be the new "safe" way to the tech world.

TSC Tax Forum aims to provide general tax information. It cannot and does not attempt to provide individual tax advice. All readers are urged to consult with an accountant as needed about their individual circumstances.