(MONEY Magazine) – Liquid Yield Option Notes, known as LYONs, combine the best features of convertible securities and zero-coupon bonds. Holders of these long-term notes can convert them into common shares of the issuing company whenever they please, or they can sell them back to the company at specified prices, usually at one particular time each year. Meanwhile the notes accrue interest at rates as high as 11.7%.

''LYONs limit your risk while offering the potential for capital gains if the stock market rallies substantially,'' says John Calamos, a money manager in Oak Brook, Ill. who specializes in convertibles. Like any zero-coupon issue, though, LYONs have a drawback: unless you hold them in a tax-deferred Individual Retirement Account or Keogh plan, you will have to pay taxes on the interest that accrues even though it is not paid out to you. The highest-yielding LYON that Calamos recommends is Beverly Enterprises, an operator of 1,125 nursing homes mostly in California, Florida and Texas with revenues of $2.1 billion. The note was recently trading over the counter for $271.25 and can be redeemed for $296.36 on Sept. 30, which gives it a yield of 11.7%. It is convertible into 13.32 shares of Beverly common at $20.38 a share. Calamos also likes the LYON issued by $10 billion Merrill Lynch. The note sells for $226.25 and can be redeemed for $238.81 on Aug. 15 for a yield of 9.5%. The LYON converts into 5.31 common shares at $42.61 each. In addition, Calamos favors the note issued by Lomas and Nettleton Financial, a $1.15 billion Texas mortgage broker. This LYON costs $282.50 and can be redeemed for $301.32 on Feb. 1, 1989, for a yield of 6.38%. The note converts into 9.3 shares of common at $30.38 each.

CHART: TEXT NOT AVAILABLE CREDIT: WARREN ISENSEE CAPTION: Today's top bonds The longer a bond's maturity, the higher its yield will usually be - and the more its price will fluctuate. For example, if interest rates rise during the next 12 months, as many economists forecast, a 30-year Treasury (now paying 9.4%) would fall nine times as much as a one- year issue (yielding , 7.5%). To illustrate the trade-off between risk and return, anaylsts use this chart of Treasure securities, known as a yield curve. Currently, bond strategists are recommending that you buy three- to seven-year issues, yielding 8.3% to 9%. DESCRIPTION: Bond yields for one to 30 years with best buys indicated.