How will I know if my account is using two factor authentication? Also what is an app password?
If you haven't knowingly set up 2-factor authentication, you don't have it
2-factor authentication is additional (optional) security for your hotmail ID (similar to Gmail/dropbox/lastpass/etc optional 2-factor auth).
Basically, once you enable it, you have to download an authentication app (I use the google authenticator from play store), and when you enable the 2-factor auth, it will show a QR code that you scan using this authenticator (or you can enter a numeric code manually). Once this is done, anytime you log into your hotmail account, you will be prompted for a 6 digit code that your authenticator app will generate (this code changes every 'x' seconds or so), in addition to your regular password.
(you can add trusted devices that will not require this 6 digit code for 30 days)
The idea behind this is that even if somebody can figure out your password (by watching you type, or by installing spyware on your computer, or brute force attack), they still can't access your computer till they have this random 6 digit code (which changes very frequently).
You will be prompted to (and you should) create backup codes in case you lose your phone with the authentication app.
App password - some applications (like outlook client for example) don't permit a user to enter this authentication code - so you generate a password from the hotmail website that will work without the auth code.
You can read more at
Two-step verification: FAQ - Microsoft Windows or at
https://support.google.com/accounts/answer/180744?hl=en
