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The Hindi film industry is the biggest film industry in the world while churning out out hundred of films every year. It was named as Bollywood on the lines of Hollywood in USA since it is situated in Mumbai which was earlier called as Bombay and Bambai. Not related but of important consideration, it may probably be the biggest employer in terms of people working on the sets at any given time, any given day!
Bollywood is Hindi industry situated in Mumbai (Bombay) matching Hollywood. There are other industries in India of regional movies like collywood, Tollywood etc.
Just like Hollywood, Bollywood is famous for films but in India. Bombay which was later renamed as Mumbai is famous for Indian film industry. Hindi movies are made here and produced world wide. Hence it is called "Bollywood".
I would like to make it clear that it is not the Indian movie industry which is called Bollywood. But in fact, Bollywood stands for only Hindi film industry. Tamil Telugu and other south Indian cinema have coined their own words like Tollywood, etc.
We have to emulate the west and so Indian or rather hindi film industry is given a name that sounds similar- Hollywood there and Bollywood here and there are more like tollywood ( telugu) , sandalwood ( kannada) ....LOL
Bollywood is the name given to Hindi language film industry and while combined with other language film industries it is considered to be largest in terms of Number of films produced and maybe also the no.of tickets sold.