If your Windows 7 machine is a member of an AD, or if you have UAC enabled, or if security policies are in effect, telnet more often than not must be run as an admin. The easiest way to do this is as follows
Create a shortcut that calls cmd.exe
Go to the shortcut's properties
Click on the Advanced button
Check the "Run as an administrator" checkbox
After these steps you're all set and telnet should work now.