How do I create a single .MSI (without setup.exe bootstrap)
Just turn off the prerequisites option to not generate the bootstrapper (see the Create setup program to install prerequisite components
check box on the screenshot). Anyway, even if it is generated, you are free to continue using the MSI alone. The setup.exe file doesn't affect the MSI file in any way.
Do I really need to search for presence of prerequisites?
If you are sure that all target machines will have the required components like the required .net framework version, VSTO runtime and other components required for your solution the bootstrapper is not required. It is up to you completely.
I have Launch condition. But then, I also defined the following in Setup > Properties > Prerequisites. So how do they co-exist together?
These are entirely different things. Launch condition like it sounds from its name is just a condition which lets the Windows Installer runtime to continue installation process or not (gives a warning message box). Prerequisites is the list of required components that is configured so they can be installed prior to running the MSI file. You can read more about them in the Windows Installer section.
Finally, you may find the Deploying a VSTO Solution Using Windows Installer article helpful.