Jets,

I'll try to answer your questions one at a time.

"First question:  Does this mean that my Arcam does all the digital to analog conversion inside the receiver?"

Since optical can only used for digital signals the answer is a definite YES

"Question 2: It sounds great to me.  Would a outboard DAC make it sound better?"

I looked at the specification for the Arcam receiver and it appears that the Arcam has very nice DAC built in so finding an external DAC which might "sound better" might mean that you would have to get a very expensive one. It is difficult to give a definitive answer without doing careful listening test and even then any differences in the sound may be just that, different but not necessarily better.

"Question 3:  Does all this digital routing around my house degrade the digital signal in any way?

Another definitive NO. The best to verify that this true is to find a DTS encoded audio file and try playing it. If the digital stream reaching the Arcam is in any way altered then the file will not play. Here's a link to information about how to play a DTS encoded file using iTunes: http://support.apple.com/kb/TA47850?viewlocale=en_US