Skeptical investors are trading Yahoo Inc shares at a 6.5 percent discount to Microsoft Corp's unofficial offer price, but some Wall Streeters expect the software giant to raise its bid.

UBS on Tuesday set a price target for Yahoo shares above Microsoft's $31 offer and Citi said a raised Microsoft bid was the most likely of five scenarios it saw for the unfolding drama between the world's largest software company and the ailing Internet star.

Yahoo shares closed on Tuesday at $28.98, more than $2 per share below the $31 price Microsoft offered last week. Microsoft shares have dropped about 12 percent since that offer was made, potentially cutting the value of the half cash, half stock offer.

But UBS set its price target for Yahoo at $34, saying Microsoft will do what is needed to get this deal done.

In a hostile deal the acquirer usually does not lead with its best and final offer and we would not be surprised to see Microsoft sweeten the pot somewhat to make the decision easier for Yahoo's board, the investment bank wrote in a note.

Citi has a $31 target price but said the likeliest outcome, at a 40 percent chance, was for Microsoft to raise its bid and make the acquisition after Yahoo rejected the initial offer.

It's reasonable to assume that Microsoft might be willing to increase its offer, analyst Mark Mahaney said in a note.

Citi gave a 20 percent probability that Yahoo would accept the current bid and a 25 percent chance that Yahoo would hire Google Inc to run its search operations in a lucrative contract. It saw a 10 percent chance regulators would block a deal and a 5 percent chance another bidder emerged.

Yahoo has simply said that it would consider the proposal in the context of its strategic plans.

Microsoft wants Yahoo's Internet advertising abilities, Citi said. Deal synergies would leave the acquisition reasonably priced even at a higher bid, it argued. Moreover, Yahoo has a poison pill provision and stands to do more for Microsoft if the deal is friendly -- many analysts have remarked that winning over Yahoo's rank and file would be key to the deal's success.

Finally, Citi and UBS both said that software company Oracle Corp's recent acquisition of BEA Systems, at a 14 percent premium to its initial bid, set a possible precedent of how to get a deal done.

(Reporting by Peter Henderson; Editing by Gary Hill)