Very interesting concept.
There is no problem with creating an independent virtual machine. (using something like Virtual-PC or Virtual Box).
Check if your laptop has a secondary external graphics output port. Most do, but many only allow the secondary port to be switched on when the main screen is switched off, and some only allow mirroring. You'll need to test if both the main screen and the secondary port can be enabled at the same time, and the windows desktop extended onto the slave screen. Once you've done this you can fire up the virtual machine and place it on the slave screen and maximise it.
The problem then is control. I can't think of any good way to control the VM. You couldn't just attach the keyboard/mouse to your laptop as that would interfere. Perhaps it's possible with USB keyboards/mice to plug in a second set and tweak the drivers and have the second set forwarded only to the VM, but I really wouldn't know without trying it. Apparently, virtual box supports forwarding of USB devices directly to the VM without interfering with the host OS. This would allow your friend to control the VM with a second keyboard/mouse plugged into your system. I haven't tried this personally, see the comments by Mokubai for more information. Also, looking at other answers, it sounds like the newer versions of VMWare support this too.
You could look into KVM-over-IP hardware which would allow you to plug your keyboard/mouse (and even the monitor) into the network and control the VM over the local ethernet, but the price you'll pay for that you could buy multiple replacement PCs. I also don't know if KVM-over-IP requires specific hardware support at the PC end (for scraping the image from the PCIe bus or something), which the VM might not support.
You might want to read on the Open KVM page and see if they have anything that would help. Also Synergy is a tool that allows keyboard/mouse control over a network, but your friend would still require a PC to plug his keyboard/mouse into to be able to control the VM over the network, but that would then defeat the point for your requirements.
I'd be really interested to hear if you manage to get this working - definitely post back if you figure anything out.