It really upset me. An asian couple walked past or house as we were getting in the car. DS2 asked me why "ladies from that country have a red spot on their forehead?" I was about to explain as best I can when he said "I know it's called a Paki spot" 
He was genuinely shocked to be told he's said something wrong, he really did think that's what it's called. I explained what it means and why it's offensive and I'm sure he won't use the term again, but what can I do about him repleating things he doesn't properly understand?
We 't live in a particularly mulitcultural area, but he does have a handful of black and asian children in his school and he's friendly and popular with all of them, so I'm certain he's not deliberately unkind to them and I know he doesn't judge people by colour etc, but he'sobviously hearing this stuff somewhere and I'm very worried he's going to repeat it within earshot of someone other than me.