In the fictional universe of Harry Potter, 'mudblood' is a highly-offensive term for someone of muggle descent.
Many supposedly pure-blood wizards consider themselves superior to the rest. However, when the term is first used in the series, Hagrid points out that no wizard is truly pure-blood, as that would be pushing inter-breeding too far; there just aren't enough pure wizarding families to support pure-bloodedness for terribly long. Later in the series it's made apparent that most of the 'pure-blood' families are closely intertwined do to attemps to avoid soiling their blood. As commented by Sirius Black, 'Molly [Weasley] and I are cousins by marriage and Arthur [Weasley]'s something like my second cousin once removed', and he's also first cousin to Narcissa Malfoy née Black and Bellatrix Lestrange née Black, and first cousin once removed to Nymphadora Tonks.