How do I use the mail merge feature so that it displays Sir for Mr. and Madam for Mrs.?

The easiest way is to add an extra column in your list of recipients that contains the appropriate term of address. This can then be inserted into your document as another mail merge field in the same way as the person's name. You could input this column manually, or generate the correct term of address using a formula in Excel, based off the Title field. Note that this doesn't work for non-gender-specific titles, so you'll have to fill those in manually. You can make a formula that outputs a blank for those rows. You'll need the "IF" and "OR" functions. Look those up using the formula wizard for information about how they work.