[shadesbass]

Originally Posted by SlowRunner

Thanks, Guys (especially, Shadesbass!)

I had to read through the Shadesbass's guide twice to take all the information in; I now can visualise how the optical line in/out now works and understand why the sound quality (through an external DAC and amplifier) would be that much better than, say, my H340.

No problem. I'm glad it was useful!

Originally Posted by SlowRunner

There is still some confusion in my mind, though, about recording with the optical line in - would I need to buy a microphone with a mini toslink? Does such a thing exist or am I talking complete tosh?

A microphone produces an analogue electrical signal (its operation is exactly like a speaker in reverse), so you will not find a microphone with an optical output.

A similar signal chain exists for the input to the H1xx as the output:
| Microphone | -> | Amplifier | -> | H1xx line-in |
OR
| Microphone | -> | Amplifier | -> | ADC | -> | H1xx optical-in |

Note that the amplifier 'module' above is not the same as the headphone amplifier in the output signal chain above. They perform different roles and are not interchangeable.

A lot of microphones require a separate amplifier to increase the signal strength to line level and sometimes to power the microphone if it is a condenser type (see here for different microphone types).
Some microphones do have small integrated amplifiers and therefore do not need a separate amplifier (although many still benefit from one).

The line-in of the H1xx is generally considered to be pretty good, so investing in a separate ADC to feed the H1xx optical input would not be a cost effective improvement in sound quality IMHO. You would be better off spending more money on a good mic setup.
Check out this thread for some useful live recording and microphone tips.

Originally Posted by BBD

Does this mean I should get a new amp for the home system? I currently hook up my DAPs to the RCA jacks w/ a Y-cable (it's a Monster--bought it before I knew better, though it works a treat), but would a different connection be needed to take full advantage of the optical-out?

To take advantage of the optical output, you will need an external DAC, either in the form of a separate unit or integrated into an amp/receiver (i.e. one with digital inputs). If you're happy with the other features of your current amp, I would suggest looking into a standalone DAC.
Any external DAC you consider must obviously surpass the quality of the H1xx internal DAC, otherwise you may as well just use the line-out as you are currently doing.
A mid-fi (Sony, Phillips etc.) amp/receiver with digital inputs will probably not produce significantly better results than your current setup, as the H1xx DAC is reasonably good IMHO.

Of course, if you want ultimate sound quality you should consider spending $50k on a Meridian Audio processor and DSP speakers, as this would keep the signal in the digital domain right up until the last minute.